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Do CEOs Care What Shareholders Think?

Yea or nay on say on pay?

The problem is familiar: We're disgusted by how extravagantly many CEOs are compensated these days. Remember hearing how, some 30 years ago, the average CEO earned about 30 to 40 times what the average American worker did? Remember reading a bunch of years ago that that had quickly risen to more than 100 times the average worker's pay? That's galling enough, but then there was this: As of 2007, the average CEO raked in fully 344 times what the average worker earned.

Has that been plummeting recently? Not so much.

Many CEOs are earning tens of million of dollars in salaries and other compensation. Worse still, many CEOs are taking home those huge salaries even though their companies lose money and their shareholders are suffering. (You can find lists of the most overpaid CEOs in various financial publications.)

Solving the problemI proposed a solution in December -- having would-be CEOs compete in auctions for the jobs, so that those who would accept the least amount of money would get the jobs. I have not heard of any companies using this strategy.

A less bold way to combat the problem has been adopted by some companies, though, with shareholders demanding that it become more widespread: permitting shareholders to voice their approval or disapproval of executive pay packages via nonbinding votes. This is called "say on pay," and you'll find it on the proxy ballots of many companies. It's slowly gaining traction, and I would guess that over many years we'll come to see many companies featuring it. (Aflac(NYSE:AFL), for example, adopted it without being forced to.)

Things might change faster than that, though. Congress has recently been looking at making it a mandatory practice for all public companies. The House of Representatives has passed a say-on-pay bill, and the Obama administration supports the provision.

Here are some companies where say-on-pay proposals have been passed by majority votes of shareholders:

Apple(NASDAQ:AAPL)

Pfizer(NYSE:PFE)

Valero Energy(NYSE:VLO)

Honeywell(NYSE:HON)

KB Home(NYSE:KBH)

Edison International(NYSE:EIX)

For and againstI used to think that say on pay was a rather toothless and ineffective way to combat the problem. After all, the votes would be nonbinding. But then I realized that boards of directors would have to go against the shareholders who elect them, and whose interests they're supposed to represent, if they overpaid the executives. I realized that the say-on-pay system might actually work to some degree.

One reason I think it might work is that so many CEOs are actively fighting the proposal. According to a USA TODAY survey of 31 current and former CEOs of large companies, 77% were against say on pay. Many CEOs are going public and questioning why we don't vote on congressional salaries, or salaries of other workers. Their opponents point out that if their compensation packages weren't over the top, shareholders likely would approve them.

Some worry about how sensibly shareholders will vote. Here are some considerations they might take into account:

If a company is making billions of dollars, it might not be so objectionable to pay the CEO millions of dollars. If the CEO has helped the company perform well and grow, perhaps he or she earned a big paycheck.

But sometimes a company can have a great year for reasons not related to the CEO, such as a spike in demand for its products or services, or a steep fall in its costs. Or, in a hard economy, a CEO might very skillfully keep a company from losing money, but a quick glance might suggest lackluster performance. Shareholders should assess the situation carefully, to determine whether the CEO has earned a big payout.

I see mainly pluses in the proposal. For one thing, it might improve communication between CEOs and shareholders. CEOs might now have more of an incentive to detail the challenges they're facing and how they're tackling them. They might work harder to help shareholders appreciate exactly what they do.

So pay attention to this development; pretty soon you may be voting on the compensation for many of the people running the companies you own shares of. And if you want to take a stronger stand on the matter, then consider not investing in a company that comes out against say on pay. After all, if a company's executives don't want its shareholders to hold them accountable, why should shareholders have faith in management?

Author

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian